The Optimal Structure of Securities under Coordination Frictions

Abstract

We study multiagent security design in the presence of coordination frictions. A principal implements a project whose value increases with an unknown state and the level of agents’ participation. To motivate agents’ participation, the principal offers them multiple monotone securities backed by the project value. More participation results in a higher project value, making participation decisions strategic complements. Miscoordination arises because agents cannot precisely infer others’ decisions from noisy observations about the state. We identify two objects in security design—“payoff sensitivity” and “perception of participation”—that determine the impact of miscoordination. To mitigate the adverse impact of miscoordination, the two objects should be matched assortatively over agents. This mechanism implies a multitranche structure where senior tranche–holders, who are more robust to miscoordination, participate more aggressively and help alleviate junior tranche–holders’ fear of miscoordination. The principal’s ability to differentiate agents in security format is crucial to whether differentiation is desirable.

Keywords: contracting with externalities, coordination frictions, security design, global games

JEL Classification: D71, D83, D86, G32, L24